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Frank Heinemann · Ulrich Klüh
Sebastian Watzka Editors
Monetary
Policy, Financial
Crises, and the
Macroeconomy
Festschrift for Gerhard Illing
Monetary Policy, Financial Crises,
and the Macroeconomy
Frank Heinemann • Ulrich KlRuh • Sebastian Watzka
Editors
Monetary Policy,
Financial Crises,
and the Macroeconomy
Festschrift for Gerhard Illing
123
Editors
Frank Heinemann Ulrich KlRuh
Chair of Macroeconomics Darmstadt Business School
Technische UniversitRat Berlin Hochschule Darmstadt
Berlin, Germany Darmstadt, Germany
Sebastian Watzka
IMK - Macroeconomic Policy Institute
Hans-Böckler-Foundation
Düsseldorf, Germany
ISBN 978-3-319-56260-5 ISBN 978-3-319-56261-2 (eBook)

DOI 10.1007/978-3-319-56261-2
Library of Congress Control Number: 2017951194
© Springer International Publishing AG 2017

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Preface
This volume contains invited contributions by (former) students, colleagues, and

friends of Gerhard Illing, whose 60th birthday served as an occasion for collect-
ing these articles. Nearly all contributions were presented in a special birthday
symposium.
Gerhard Illing’s research focuses on the relation between monetary policy,
financial crises, and the macroeconomy. He has often argued that financial and
macroeconomic instabilities are a key issue for our societies, an important research
topic, and a challenge for macroeconomic policy. He encouraged students and
colleagues alike to take the issues of financial crisis prevention and resolution
seriously, even at a time when most macroeconomists believed that the great
moderation had made crises in mature economies a thing of the past. His pioneering
approach combines strong theory to explain causal relationships with a clear view
on data and general macroeconomic developments. His proficiency with game
theoretic and microeconomic methods has helped him (and others) to advance
macroeconomics in novel and very fruitful directions. In particular, he contributed
to making mechanism design an important tool for macroeconomic policy analysis.
The editors owe Gerhard many thanks for his inspiring views. His open, curious,
and analytical mind often pointed us to upcoming research topics, policy debates,
and methodological innovations.
Many chapters in this volume follow the approach of applying microeconomic
and game theoretic methods to monetary policy and financial crises. They also con-
tain interesting empirical results, reflecting Gerhard’s view that evidence antecedes
any application of models. They discuss recently suggested measures for central
banks’ responses to liquidity shortages and to the liquidity trap. They develop
methods for assessing the potential of contagion via the interbank network and
for capturing the interaction between micro- and macroprudential regulation. In
addition, they contain empirical analyses of macroeconomic effects of German
unification and current developments in the German housing market.
A wider audience might be especially interested in the chapters that point
to avenues for re-conceptualizing and renovating macroeconomics. One potential
starting point for such renovation is the application of new microeconomic methods
v
vi Preface
to macro problems. This is reflected in an insurance-based approach to evaluate

proposals for solving the sovereign debt problem in the Euro Area. It is also
clearly visible in a new explanation for rising income inequality that is based on
contract theory and advances in IT technology. Re-conceptualization, however, will
also require a more fundamental, transdisciplinary critique of the current state of
macroeconomics. Such critique is provided in a detailed analysis of the dogmatic
superstructure of the process of financialization, which many believe has been an
important driver of the developments in recent decades.
The symposium on which this volume is based took place at Ludwig-
Maximilians-University (LMU) in Munich from March 4 to 5, 2016. The conference
was characterized by an extremely lively exchange between academics and
practitioners, very much in the spirit of Gerhard’s approach to economics. We
would like to thank all participants for their participation in the conference and their
contributions to this volume.
The atmosphere, depth, and policy relevance of the symposium greatly benefited
from two policy panels. The panelists (Peter Bofinger, Charles Goodhart, Hans-
Helmut Kotz, Bernhard Scholz, and Hans-Werner Sinn) have done a great job in
translating research results into policy advice and to enliven the discussions during
sessions and afterward. We thank them for their presence and their inputs.
One secret of a successful conference is a generous host providing the necessary
infrastructure and a committed team doing the background work. Many thanks go
to the Ludwig-Maximilians-University (LMU) for its support and hospitality. It
allowed all participants, many of who had spent an important part of their career
at LMU, to feel very much at home and at ease. Our special thanks go to Mrs.
Agnes Bierprigl and to the other team members at the Seminar for Macroeconomics.
Their dedication and effort were crucial to make this event happen and to ensure its
success.
We also express our thanks to Mr. Alen Bosankic, Ms. Jasmina Ude, and Mr.
Moritz Hütten for reading proofs and preparing chapter drafts. The team at Springer
Publishing has not only been very patient but also very forthcoming with support
and assistance.
Finally, it is our pleasant duty to acknowledge financial support from Deutsche
Pfandbriefbank and Cesifo.
Berlin, Germany Frank Heinemann

Darmstadt, Germany Ulrich Klüh
Düsseldorf, Germany Sebastian Watzka
Contents
Monetary Policy, Financial Crises, and the Macroeconomy:

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 1
Frank Heinemann, Ulrich Klüh, and Sebastian Watzka
Part I Liquidity From a Macroeconomic Perspective

Balancing Lender of Last Resort Assistance with Avoidance
of Moral Hazard.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 19
Charles Goodhart
Optimal Lender of Last Resort Policy in Different
Financial Systems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 27
Falko Fecht and Marcel Tyrell
Network Effects and Systemic Risk in the Banking Sector .. . . . . . . . . . . . . . . . . 59
Thomas Lux
Contagion Risk During the Euro Area Sovereign Debt Crisis:
Greece, Convertibility Risk, and the ECB as Lender of Last Resort .. . . . . . 79
Sebastian Watzka
The Case for the Separation of Money and Credit . . . . . . .. . . . . . . . . . . . . . . . . . . . 105
Romain Baeriswyl
Part II Putting Theory to Work: Macro-Financial Economics

from a Policy Perspective
(Monetary) Policy Options for the Euro Area: A Compendium
to the Crisis .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 125
Sascha Bützer
On Inflation Targeting and Foreign Exchange Interventions
in a Dual Currency Economy .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 163
Ivana Rajković and Branko Urošević
vii
viii Contents
Macroprudential Analysis and Policy: Interactions

and Operationalisation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 177
Katri Mikkonen
Are Through-the-Cycle Credit Risk Models a Beneficial
Macro-Prudential Policy Tool? . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 201
Manuel Mayer and Stephan Sauer
Assessing Recent House Price Developments in Germany:
An Overview .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 225
Florian Kajuth
Part III Re-Conceptualizing Macroeconomics:

An Interdisciplinary Perspective
German Unification: Macroeconomic Consequences
for the Country .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 239
Axel Lindner
Approaches to Solving the Eurozone Sovereign Debt Default Problem .. . . 265
Ray Rees and Nadjeschda Arnold
Appraising Sticky Prices, Sticky Information and Limited Higher
Order Beliefs in Light of Experimental Data . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 297
Camille Cornand
Rising Income Inequality: An Incentive Contract Explanation . . . . . . . . . . . . 307
Dominique Demougin
No More Cakes and Ale: Banks and Banking Regulation
in the Post-Bretton Woods Macro-regime . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 325
Moritz Hütten and Ulrich Klüh
Greetings from Bob Solow . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 351

Monetary Policy, Financial Crises,
and the Macroeconomy: Introduction
Frank Heinemann, Ulrich Klüh, and Sebastian Watzka
Since the early 1970s, financial instability has been on the rise. For some time
this trend had been mainly associated with emerging markets, even though there
were occasional crises in some high-income countries as well. In the industrialized
world, the increasing instability of economic systems had been masked by the
fact that macroeconomic aggregates appeared to become more stable. The subdued
fluctuations of the Great Moderation seemed to validate the view that crises and
depressions were a thing of the past.
This changed in 2007/2008, when a global financial crisis of yet unknown
magnitude and character hit the U.S., Europe, and, through spillovers, the whole
world. This crisis validated all those who had warned that depressions were still
one of the main problems with which economics had to cope. It brought up many
new and controversial policy topics that still are not resolved satisfactorily. Also, it
has put into question many of the dogmas that had characterized macroeconomic
thinking since the late 1970s.
Gerhard Illing is at the forefront of those who have constantly argued that
financial and macroeconomic instabilities are a key issue for our societies, an
important research topic and a challenge for macroeconomic policy. Thus, he is one
of those whose views have been validated by the crisis. This volume is a collection
of contributions to a symposium held to celebrate Gerhard’s sixtieth birthday.
F. Heinemann
Technische Universität Berlin, Berlin, Germany
e-mail: [email protected]
U. Klüh ()
Hochschule Darmstadt, Darmstadt, Germany
S. Watzka
IMK - Macroeconomic Policy Institute at the Hans-Böckler-Foundation, Düsseldorf, Germany
© Springer International Publishing AG 2017 1

F. Heinemann et al. (eds.), Monetary Policy, Financial Crises,
and the Macroeconomy, DOI 10.1007/978-3-319-56261-2_1
2 F. Heinemann et al.
Gerhard’s approach to macroeconomic analysis is unique in the way it balances

different perspectives. He is one of the few German economists with an eye
for the demand side of the economy. But he also looks at the supply side.
He is a skillful microeconomist and he has used his microeconomic expertise
frequently to illuminate macroeconomic puzzles. In spite of this ability, Gerhard
is a macroeconomist by heart who does not force micro-foundations upon any
macroeconomic problems. Finally, he is an economist with a strong preference for
academic rigor and policy relevance, and wants to achieve both at the same time.
Gerhard’s research interests are multifaceted. He has published and edited books
and papers on diverse topics, such as game theory (Holler and Illing 2009), the
digital economy (Illing and Peitz 2006), and spectrum auctions (Illing and Klüh
2004). But his main interest in recent years has been (i) the nature and role of
liquidity for macroeconomic and financial policies; (ii) the design of policies,
instruments, and strategies to cope with the macro-financial problems characterizing
modern capitalist societies; (iii) the integration of new methods and views into
macroeconomic thinking.
This volume is organized along the above three lines of research. Part I deals
with liquidity and contagion of liquidity crises. Liquidity becomes a relevant issue
through frictions, in particular those analyzed by information economics (Illing
1985). It has many facets, ranging from market and funding liquidity to monetary
forms of liquidity. And it has been at the heart of the analysis of financial crises and
the optimal response to their occurrence (Illing 2007).
Part II looks at policies, in particular those at the nexus between macroeconomics
and finance. The crisis has brought about a revival of aggregate demand policies, a
trend already foreseen in Illing (1992) and Beetsma and Illing (2005). It has put
monetary policy in a very difficult position, caught between macroeconomic and
financial stability (Cao and Illing 2015) and faced with the manifold challenges of
the zero lower bound (Illing and Siemsen 2016). The crisis has made necessary a
re-assessment of fiscal policy (Illing and Watzka 2014) and public debt (Holtfrerich
et al. 2015), and it has raised the question of how to complete the re-regulation of
the financial sector, with a view to strengthen its macroprudential dimension (Illing
2012).
Part III presents approaches for a re-conceptualization and renovation of macroe-
conomics. The failure of large parts of the economics profession before and during
the crisis has made such a re-conceptualization necessary. Economists have trusted
too much in efficient markets. As a consequence, they did not warn sufficiently
about the imbalances that were building up. During the crisis, they were not able
or not willing to prevent the austerity backlash that has kept so many economies in
depression mode.
Looking for new approaches in macro-financial economics does not mean,
however, that everything that has been done before should be disposed of. Those
like Gerhard who have studied financial instability before the crisis have come up
with important and often surprising insights (see, e.g. Heinemann and Illing 2002;
Goodhart and Illing 2001). The problem has not been a lack of good theory, nor of
good empirics, but a missing focus on relevant questions.
Monetary Policy, Financial Crises, and the Macroeconomy: Introduction 3
1 Liquidity and Contagion of Financial Crises
It is difficult to overestimate the role of liquidity as a key or possibly even

paramount concept in macroeconomic thinking. Monetary macroeconomics as a
discipline could not be constituted without the notion of liquidity. In the history of
economic thought, liquidity has been central in constituting different paradigms of
macroeconomics. It has informed early discussions of macroeconomic issues, such
as in Gresham’s law. It has been central to physiocratic views of the economy, in
which some see the beginning of economic thinking in circular flows. The concept
of liquidity is closely related to Say’s law (Klüh 2014), and it is one of the main
features of Keynesian economics and all “modern macroeconomic” DSGE models.
The view on the role of monetary aggregates divides different schools and is a
defining element of many controversies regarding monetary policy and financial
market regulation.
Proponents of real business cycle theory and perhaps growth economics might
argue that liquidity and monetary effects are only temporary and the welfare losses
arising from fluctuations are small in comparison to the long-run gains of real
economic growth. Indeed, if one assumes complete markets and perfect rationality,
liquidity is of no major concern. This view, however, has been largely knocked
down by recent experience. As soon as one starts to look at the pathologies of
capitalist societies, focusing on liquidity becomes inevitable (Goodhart and Illing
2001) because the long-run effects of misdirected investment activities, long-
run unemployment, and high youth unemployment rates that are associated with
financial crises are estimated to protract growth for several years with no chance of
returning to the old growth path.
In spite of its overwhelming importance, many economists perceive liquidity
as a riddle within an enigma. Trained to think in models in which real exchange
dominates, the importance of the nominal dimension of economics that directly
follows from the notion of liquidity is often difficult to accept. More importantly,
the frictionless or friction-poor world of many models provides only little space for
a concept that is largely a consequence of frictions. These frictions are many and
most can be traced back to incomplete information.
But what is liquidity? And when does it (or a shortage of it) constitute a
problem? Charles Goodhart (2017), in the first chapter of this volume, sets out
his analysis by asking these fundamental questions. He contextualizes his analysis
of lender-of-last-resort (LOLR) policies by first looking at the nature of liquidity
problems. Liquidity shortages have a dual nature. On the one hand, a lack of
liquidity in most cases reflects some kind of solvency concern: if payments and
repayments are certain, both with respect to their incidence and with respect to the
details of their occurrence, the ability to borrow ensures liquidity. On the other
hand, illiquidity does not necessarily reflect actual solvency problems, because
fundamentally solvent banks can become illiquid due to the network effects in
financial markets. Goodhart argues that there is no clear cut distinction between
solvent but illiquid and insolvent banks.
Thus, the provision of liquidity during banking crises must compromise two
goals: on one hand, systemic crises should be avoided because of the huge losses to
society, on the other hand, any implicit guarantee for providing liquidity to banks
in distress raises concerns that banks may game the rules and exploit tax payers.
Moral-hazard should be avoided.
Against this background, determining optimal last resort policies involves dif-
ficult judgements. Depending on which of the two views of liquidity shortages is
emphasized, very different policy recommendations follow. If liquidity problems
are mainly a reflection of solvency problems, policy should be more restrictive. If
liquidity problems are a reflection of the inherent fuzziness and non-linearity of the
liquidity-solvency nexus, central banks should have maximum flexibility to prevent
unnecessary harm to the economy.
The standard advice in the literature has been influenced strongly by the first
view. To prevent lending to insolvent and thus likely irresponsible players, the
central bank should mostly lend to the open market and not to individual banks
via LOLR measures. The fear of unwarranted support to failed institutions has
also dominated changes in crisis-management arrangements after the crisis, such
as the Dodd-Frank act. As a consequence, there is a risk that central banks will have
insufficient flexibility when the next crisis comes.
Goodhart argues that this underestimates the importance of the second view, and
in particular the dynamics of contagion. Provision of liquidity to the market is not
helpful to stave off contagious banking crises, because the market allocates extra
liquidity to those institutions who are not directly affected by the crisis. While open-
market operations may prevent a complete meltdown, they may leave us with a
partial meltdown and severe macroeconomic consequences.
Instead, Goodhart recommends that a central bank should treat the first bank to
run out of liquidity most toughly up to letting the bank fail, but provide liquidity at
more favorable conditions to other banks in distress that may have been affected by
contagion. This mechanism raises incentives for banks to avoid illiquidity but saves
them from the network effects and, thereby, avoids systemic crises. Nevertheless,
any LOLR policy creates moral-hazard incentives. For Goodhart, the only way
to properly take this into account would be a much more ambitious approach to
change incentives. The rules should be such that they come as close as possible to
an unlimited liability arrangement, for example through multiple liability schemes
and a much stronger emphasis on bail-in-able debt.
The question, whether central banks should provide liquidity to the market or to
individual institutions in distress, is also analyzed by Falko Fecht and Marcel Tyrell
(2017) in the second chapter of this volume. Building up on a model by Diamond
and Rajan (2001), they ask whether the answer may also depend on the nature of
the financial system. A key ingredient are the losses that arise if a bank needs to
liquidate or sell projects that it cannot continue to finance. Fecht and Tyrell assume
that in bank-based financial systems, such as continental Europe, intermediaries
have more information about the profitability of projects that they are financing than
in a market-based system such as the United States. Bank-based financing allows
banks to extract a larger share of the liquidation value of a project, while the market
value to outside investors is higher in market-based systems, where information is

less asymmetric.
From these assumptions, Fecht and Tyrell derive a number of results that inform
us about differences in LOLR policies between the two systems. They show that
the provision of liquidity by open-market operations leads to inefficiencies that are
more severe for a bank-based than for market-based system. Providing liquidity to
individual institutions is more preferable in a bank-dominated system.
The employed model does not account for moral hazard effects that may provide
a general argument for open-market operations. LOLR assistance to individual
institutions may also be more costly for the central bank. Assuming that these
costs are comparable in both systems, Fecht and Tyrell conclude that in bank-based
financial systems with their rather illiquid assets, LOLR assistance to individual
institutions may be a more favorable instrument than providing liquidity to the
market via open-market operations, while the opposite may be true in a market-
oriented financial system.
The model by Fecht and Tyrell considers contagion via the relative prices of
assets in terms of liquidity, but it does not account for contagion arising from direct
links between banks. These contagion effects are the reason why Goodhart rejects
the clear distinction between insolvency and illiquidity. The dynamics of contagion
that are at the heart of Goodhart’s analysis are largely a consequence of the fact that
financial systems are complex networks. Should the central bank or supervisor have
a very good grasp of the systemic consequences of a specific support measure or
punishment, official responses to liquidity problems could be much more targeted.
The degree of moral hazard would be reduced and the flexibility of the central
bank increased. Moreover, one could start devising incentives to reduce systemically
relevant network effects, for example through special rules for money-center banks.
In his contribution, Thomas Lux (2017) argues that the pre-2008 mainstream
approach to macroeconomic research had “deliberately blinded out” these issues,
mainly because of the purported efficiency of financial markets. The post-crisis
research on interbank networks and contagion dynamics is becoming more receptive
to the alternative view, which emphasizes market inefficiencies, behavioral aspects,
non-linearity, and non-standard probability distributions.
Lux shows that this literature has yielded a set of important stylized facts ranging
from topological features such as core-periphery structures to stability characteris-
tics (such as the surprising persistence of certain linkages). He also recognizes first
successes in explaining the self-organization of the system. However, attempts to
theoretically measure and then internalize network externalities are in the fledgling
stages, at least academically. Thus, the potential for informing policies to change
the system’s structure in an attempt to contain contagion remains limited.
Lux presents simulations of a stochastic model of link formation and spillovers.
An individual default of one bank affects in most cases only few other institutions.
But for a small number of banks, their default triggers a system-wide collapse. Most
stress tests by monetary authorities have only considered the financial stability of
individual institutions and neglected the propagation of liquidity shortages through
the banking system. One reason is data limitations. Moreover, as contagion happens
through a multitude of channels and because balance sheets change quickly, policies
grounded in theory may quickly be outdated. What, then, is the role of the new
generation of models described in the chapter? According to Lux, network models
may help to get a better grasp of the capital cushions needed to prevent shocks and
shock transmission in an otherwise fragile system. By focusing on capital buffers,
Lux picks up an argument that has been crucial for the crisis response so far: more
targeted measures focusing more explicitly on the structural problems would be
desirable. However, a lack of knowledge about the impact of these policies precludes
their implementation. The second-best method might be to focus on capital, an
argument implicit in Illing (2012, p. 17).
Sebastian Watzka (2017), in his chapter, considers the liquidity risk again from a
different angle. He discusses the euro area debt crisis—and in particular the Greek
tragedy—under the assumption that some of the risk premia in Greek government
bond yields were due to what the ECB referred to as “convertibility” risk, i.e.
the break-up risk of the euro area. This idea has forcefully been demonstrated by
De Grauwe and Ji (2013) arguing that an individual euro area member country is
naturally lacking a LOLR and this by itself would generate multiple equilibria with
unduly high liquidity risk premia for countries of which investors believe that public
debt is too high. To test for such effects, Watzka empirically assesses how important
non-fundamental contagion was during the early phase of the Greek debt crisis. He
concludes that Mario Draghi in his famous 2012 London speech reassured markets
that the ECB was in fact acting as LOLR for euro area countries, if certain criteria
were met.
A crucial and usually innocuous assumption in most papers on banking crises
is that money and credit are intrinsically conjoined. Does this need to be the case?
The crisis shows that the pursuit of price stability (which had been achieved almost
universally before 2007) does not imply financial stability. In contrast, there are
important ways in which policies to achieve one can be detrimental to the other.
An important reason for this perceived antagonism is the nature of money
creation through credit markets. It is therefore not surprising that a radical departure
from this approach has been envisioned by some. In his contribution to this volume,
Romain Baeriswyl (2017) argues that the close connection between money and
credit is a relic of the Gold Standard. With unredeemable fiat money, there are few
reasons to stick with it. But what would be the inter-sectoral and inter-temporal
implications of such a departure? Baeriswyl argues that the provision of liquidity
via the credit market has the largest effects on private credit volume and primarily
stimulates demand for goods that are bought on credit such as real estate. Hence,
expansionary monetary policy fuels asset prices and may cause price bubbles, along
with its stimulus effects for aggregate demand.
For targeting consumer price inflation, lump-sum transfers of money to con-
sumers are likely to be more effective. Lump-sum transfers from the central bank to
the citizens sound radical at first, but has some important advantages. In Baeriswyl’s
view, these advantages strongly outweigh the disadvantages. In particular, the
pursuit of price stability would no longer require destabilizing the financial system
through credit creation or contraction. Finally, there would be less interference with
inter-temporal decisions, because interest-rate policies prevent the free adjustment

of credit markets to supply and demand of real resources as savings and investment.
By contrast, lump-sum transfers of money stimulate demand without directly
affecting interest rates.
Baeriswyl’s analysis does not stop here. Separating money from credit would
have far-reaching implications that go beyond monetary policy. For example, it
seems to require a departure from fractional-reserve banking. Lump-sum transfers
also require a re-assessment of the way central banks absorb liquidity. Proponents
of credit-based money creation often raise three interrelated arguments against its
abolition. First, they argue that lump-sum transfers constitute fiscal policy. Because
of their distributional consequences, transfers need to be decided upon by elected
officials, not technocrats. Second, they believe that the current system is better than
often assumed in bringing investment and savings in balance. Has it not allowed
economic growth for large spells of the last two centuries? Third, they question
the need to focus so much attention on central bank policy. If fiscal policy is pro-
active, a credit-based monetary system can work smoothly. Fiscal policy takes center
stage in absorbing excess liquidity and savings and in making sure that investment
expenditures are sufficient. It can also take the necessary steps to prevent or escape
a liquidity trap.
Unfortunately, European fiscal policy currently appears rather dysfunctional: it
neither uses the opportunity of a huge excess supply of savings and demand for safe
assets to boost public investment, nor does it exploit the large multiplier effects of
fiscal policy in a liquidity trap for stimulating demand. This has raised a discussion
for helicopter money as an additional instrument for central banks. Baeriswyl just
goes one step beyond and suggests to replace the credit channel completely by a
helicopter.
2 Putting Theory to Work
Macroeconomics is a policy-orientated science. A main challenge is to take theory

and empirical scrutiny as far as possible while always having policy in mind.
Bringing cognitive interest and policy relevance together has always been a hallmark
of Gerhard Illing’s thinking. This has been most visible during the symposium that
has given rise to this volume. A frequent comment of participating central bankers
was that if academic conferences would always be so interesting, they would have
rather remained in academia. While all three parts of this book reflect this practical
side of macroeconomics, this section puts special emphasis on it.
Financial markets and institutions are not just playing a dominant role in
transmitting monetary policy to the real sector. In recent years, they have often
absorbed policy impulses. Macroeconomic policy feeds into the peculiar logic of
expansion and contraction that increasingly characterized the financial sector. From
a certain point on, however, periods of financial contraction become a source of
fiscal and growth risk. Finance, thus, simultaneously charges and discharges policy.
As fiscal policy has taken a backseat since the beginning of the 1970s, monetary
policy has found itself in the center of this double role. It faces a difficult conflict.
On the one hand, it tries to fulfill its role as a levee against the negative real
consequences of financial contraction. On the other, it tries to enclose the dangers
of excessive financial expansion. As the instruments to achieve the first may inhibit
or even foil the instruments available to achieve the second, a conflict emerges. An
intriguing analysis of this conflict and its relation to liquidity issues is provided in
Cao and Illing (2010, 2011).
The challenges for monetary policy are all the more acute when fiscal policy
becomes increasingly passive. This is most obvious in the case of the Euro crisis,
which is surveyed and analyzed in the first chapter of the second part. Here, Sascha
Bützer (2017) first illustrates the dramatic failure of fiscal policy. The institutions
of the European Monetary Union lack mechanisms to pool risks across its member
states and put the burden of adjustment on these national states while stripping them
of some of the most effective instruments to achieve these adjustments, like national
interest and exchange rates. Integrated financial markets would be an alternative to
fiscal risk pooling, but financial integration stopped short of the standards achieved
in other currency areas. Apparently, several member states have been overcharged
by these demands. An almost religious belief in austerity and structural reform has
prolonged the recession. It has led to an increase in indebtedness and thus defeated
itself. Finally, it has pushed monetary policy in a situation that is perceived as an
overburdening of its possibilities and mandate.
In Bützer’s view, monetary policy has been the victim of a cure that has nearly
proven fatal. While the detrimental effects of fiscal contraction were recognized by
many monetary policymakers, structural reforms have been viewed at as “a panacea
to jump-start growth and generate employment” (p. 143). Against the backdrop of
hysteresis, the combination of procyclical fiscal, impotent structural and insufficient
monetary policy is now yielding medium- to long-term effects.
After describing the current situation, Bützer looks at options available now.
He analyses their potential in keeping the Euro area together and leading the way
out of depression. Simultaneously, he asks whether the expansionary effects of
these policies are outweighed by their disadvantages in terms of financial stability
and redistributive effects. He concludes that conventional monetary policy and
quantitative easing “have run out of steam at the zero lower bound and increasingly
pose risks to financial stability, the outright creation of broad money through
lump-sum transfers from the central bank to private households may well be the
most effective measure to achieve the Eurosystem’s primary objective and lift the
economy out of its slump” (p. 155).
He recognizes that there are dangers associated with putting the central bank
in such an exposed position. In the end, however, he favors managing credibility,
independence, and financial stability risk to letting the Eurozone unravel.
Bützer’s analysis illustrates the ever expanding universe of central bank instru-
ments. This points to a policy challenge that emerging-market central banks have
already faced long before the crisis. In these countries, monetary policy has often
been characterized by the use of multiple instruments. Sometimes this has been due
to multiple objectives. In other cases, central banks have felt that a combination of
instruments might be preferable to achieve a single goal.
Using the example of foreign-exchange-market interventions, Ivana Rajković
and Branko Urošević (2017) develop a framework to analyze this multiplicity.
The context is a small open economy with pronounced euroization. It follows an
inflation-targeting strategy. In such a dual currency setup, the degree to which
foreign currency is employed to store value or extend credit affects how the policy
rate is set. If interest rates are the only instrument, monetary policy faces constraints
that can be relaxed by foreign-exchange interventions. The responses to domestic
and international shocks become less extreme and policy is less distortionary.
However, to successfully operate with different instruments requires pre-conditions.
In particular, central-bank risk management needs to be developed further to take
into account the cost of foreign exchange interventions. Furthermore, monetary and
macroprudential polices have to be calibrated jointly.
This important take-away from the chapter of Rajković and Urošević is further
refined in the next three contributions of this volume that deal with the conceptual
basis, measurement, and data requirements of macroprudential regulation.
Katri Mikkonen (2017) reviews recent contributions to macroprudential policy
analysis. She first looks at the relationship among macroprudential, monetary
and microprudential policies, emphasizing synergies and the need to focus on
comparative advantages. In a second part, she presents an operationalization of
macroprudential policy. Recent work at central banks has come up with new ways
of risk identification and assessment. With a view to get a holistic picture of
macro-financial risks, qualitative and quantitative techniques have been married
in innovative ways, for example in novel early warning systems. Recent work
has also come up with new views on macroprudential instruments, for example
countercyclical capital buffers, loan-to-income ratios, or a time-varying net stable
funding ratio.
Mikkonen concludes that much has been done to improve macroprudential
policy. However, policies so far cannot be based on a stable set of stylized facts
and instruments. The financial cycle has received less attention than the business
cycles. Missing data and tools to model complexity in quickly changing systems
limit the applicability of many models. “There is no universally accepted dogma for
macroprudential policy” (p. 196). Trial and error will remain important elements
of existing policy approaches. Much more empirical research needs to be carried
out.
Manuel Mayer and Stephan Sauer (2017), in their contribution, study macro-
prudential aspects of measuring credit risk. Though the practice is currently
contested, banks use their own estimates for the probability of default and the loss
given default. The respective models follow different approaches. Accordingly, an
important distinction with macro-financial relevance is the one between point-in-
time (PIT) models (using all currently available information) and through-the-cycle
(TTC) models (canceling out information that depends on the current position
in the macro-financial cycle). TTC models are often viewed as favorable for
macroprudential regulation, because credit risk estimates do not improve (dete-

riorate) in a boom (recession). Thereby, constant equity requirements are less
procyclical than if risk weights need to be adjusted when risk is measured by PIT
models.
Mayer and Sauer question the perceived superiority of TTC, performing a range
of empirical tests on the relative reliability of the two methods. They show that
TTC are more difficult to validate. Having a theoretically good but empirically
questionable method might do more harm than good. It also opens the door for
misunderstandings between the supervisors and the supervised. Taken together,
their arguments favor PIT models for measurement purposes. To compensate for
the pro-cyclical nature of these models, the authors argue for a more extensive use
of counter-cyclical capital buffers.
Florian Kajuth (2017) concludes Part II with a discussion of a current macropru-
dential topic, the rise in house prices, in particular in German urban agglomerations.
House price developments are crucial to understand macro-financial dynamics
(Illing and Klüh 2005). The analysis looks at German house prices from at least
two different angles. One the one hand, it discusses issues of data availability and
quality, comparing parametric and non-parametric approaches. In this way, it raises
awareness for an often neglected but extremely important issue: the availability
(or lack thereof) of data for macroprudential and other policy purposes. On the
other hand, the chapter asks whether there is reason for concern. Did expansionary
monetary policy result in substantial overvaluations, thus giving rise to prudential
concerns?
Kajuth provides extensive evidence for the deplorable state of property price
statistics in Germany. In particular, there is a lack of time series that go back
sufficiently in time. Moreover, existing statistics lack comprehensiveness. It is
therefore necessary to rely on cross-sectional variations of housing markets in
Germany. Using this information and a range of other sources confirms that some
urban areas do indeed seem to be overvalued. For Germany as a whole, however,
there is no indication of a bubble, at least not yet.
3 Re-conceptualizing Macroeconomics
The financial crisis has left a deep mark on the kind of topics that are on macroe-
conomists minds. New methods have evolved, and macroeconomic issues have
become more interesting to those who were previously focused on microeconomics.
Macroeconomics has changed quite a deal since Lucas’s now infamous quote
that “depression prevention has been solved” (Lucas 2003, p. 1). The chapters
in this volume reflect some of these developments. Macroeconomics is currently
undergoing a period of re-conceptualization (Blanchard et al. 2010). This period
started already before the crisis, but went largely unnoted, with few exceptions,
such as the ones discussed in Beetsma and Illing (2005). The final section of this
volume looks at five elements of this trend:

– A renewed focus on stylized facts, economic history and path dependence,
– The application of established methods to new problems, such as the institutional
structure of the Euro area,
– The application of new methods to old topics, building in particular on insights
from behavioral and experimental economics,
– The resurgence of distributional issues as a topic of macroeconomic research,
and
– The emergence of inter-disciplinary work to re-embed economics in the social
sciences and contextualize its findings.
Axel Lindner (2017), in the first chapter of Part III, shows that going back a
little further can yield important insights about the present situation. He looks at the
macroeconomic effects of German unification and argues that the German economy
had been off steady state already before unification. At the same time, Germany
seems to have been on a trajectory that very much resembles the dynamics that
we now associate with the anamnesis of the Euro crisis. In particular, investment
was trending down already before unification, and continued to do so after a brief
jump in the beginning of the 1990s. Moreover, the financial balance had been
on an increasing trend during the eighties, a trend it returned to around 10 years
after unification. The wage share in national income follows a similar pattern, yet
with the opposite sign. These observations cast some doubts on the view that these
developments were a consequence of introducing the Euro.
The problems of the Euro area are at the core of the chapter by Ray Rees and
Nadjeschda Arnold (2017). They ask whether insurance-based approaches can help
solving the sovereign default problem and argue that the economics of insurance
markets can guide a redesign of the common currency area. This redesign seeks
to preserve decentralized fiscal policy. Its main idea is to use risk-based insurance
premia as an instrument to increase fiscal discipline. Rees and Arnold encourage
the creation of an independent insurance agency. This agency ensures incentive
compatibility by promising to remove the threat of sovereign default if certain
conditions are fulfilled. Its main instrument are risk-based premia “payable ex
ante into a mutual fund that must at least break even in expectation” (p. 267). In
case of a fiscal emergency, the mutual fund arranges automatic payouts. Regular
reviews of fiscal plans, minimum insurance reserves, and reinsurance arrangements
complement the set-up.
Rees and Arnold compare this insurance-based approach with the existing
European Stability Mechanism and different suggestions for Eurobonds. They
conclude that none of these alternatives is incentive compatible, because they fail
to make the costs of default risk accountable for governments ex ante.
Camille Cornand (2017) shows in her contribution that new empirical approaches
can yield important insights about macroeconomic phenomena. In an attempt to
provide additional foundations for the non-neutrality of money, she compares the
role of three potential explanations for nominal rigidities: sticky prices à la Calvo
(1983), sticky information à la Mankiw and Reis (2002), and limits to the level
of reasoning that price setters achieve. The latter is based on the observation
that subjects in laboratory experiments fail to reach common knowledge when
information abounds.
Cornand uses the data from an experiment by Davis and Korenok (2011), in
which subjects play the role of price-setting firms in a macro-environment with
stochastic demand shocks. The data reveal a sluggish adjustment to shocks, even
if these shocks are publicly revealed. Cornand investigates which model yields the
best fit of these price adjustments and finds that the sticky-information model fits
best.
Selecting models on the basis of laboratory experiments provides an alternative
to assuming artificial frictions in macroeconomic models. Experimental data also
allow estimating behavioral parameters independently from other model parameters,
while empirical tests with macroeconomic field data allow only a joint estimation
of all model parameters. The estimated behavioral parameters may then be used for
calibrations and as restrictions in the joint estimates of other model parameters with
macroeconomic field data.
One should not underestimate the significance of these and other behavioral
insights into wage and price stickiness. The rejection of Keynesianism by Lucas and
others was largely justified with the argument that Keynesians were unable to derive
such stickiness from micro-founded models with optimizing agents. The data from
experiments and the results from behavioral economics more generally show that
nominal rigidities and non-rational expectations are just a fact of life. This makes
pragmatic reasoning much easier, as it is not hampered anymore by the requirement
that all macroeconomic variables need to be derived from rational choices.
In the penultimate chapter, Dominique Demougin (2017) analyses an issue that
more and more dominates the policy debate. After having long been relegated to
the fringes of macroeconomics, the rising inequality of income and wealth now
takes center stage. Using an incentive contract approach, Demougin provides a
novel explanation for this trend. Information and communication technology allows
managers to better monitor worker behavior. This redistributes informational rents
from the bottom to the top of the income distribution. While middle management
wins, firm owners win big. They do not just gain from a redistribution of rents from
a given output: they also benefit from increased worker effort and productivity. The
mirror image of this effect is that workers are penalized twice. They lose the rents
that they had enjoyed before, and they suffer from a work environment that requires
higher effort.
Demougin uses a standard hidden action problem to explain increasing income
inequality. The argument is solely based on the organizational structure of the firm
and, thus, provides an alternative to standard explanations based on globalization
or skill-biased technological progress. Demougin’s numerical exercise replicates
a sizeable number of crucial features of the macroeconomic environment since the
early 1970s. While technology advances, wages dynamics are at best subdued, if not
stagnant. The wage share in income declines. Working conditions are increasingly
resembling a treadmill with little space for discretionary decisions by workers.
Certain groups of the society are able to keep up as middle managers, so the wage
distribution starts to become more uneven. But the strongest implication of the rise
in information and communication technology is that the very top of the income
and wealth distribution experiences large gains, a feature that cannot be explained
by skill-biased technological progress.
Moritz Hütten and Ulrich Klüh (2017), in the final chapter of this volume, pick
up the fact that macroeconomic developments since the end of the Bretton-Woods
regime display peculiar characteristics. Not only has there been a redistribution
from the bottom to the top and from labor to capital, but in parallel, inflation
has come down and is too often close to deflationary levels. Unemployment has
become a constant feature of capitalist societies, while it was largely absent in the
decades before. Public debt as a share of GDP has trended up, in part because the
incidence of financial crisis has increased continuously. Exchange rates and other
prices on financial markets have exhibited a degree of volatility seemingly unrelated
to fluctuations in fundamental variables.
All this has taken place in a context in which the task of stabilizing macroe-
conomic and financial fluctuations has been concentrated in the hands of central
banks. These, in turn, have largely bought into the notion that some degree of
unemployment is necessary to keep inflation in check, in particular the very low
inflation targets that have become standard. Fiscal policy has been confined to
implement a regime of institutionalized austerity (Streeck and Mertens 2010). And
structural policies have often followed the prescriptions of the so called Washington
consensus.
Hütten and Klüh argue that the beginning of the 1970s is a watershed between
two ways of organizing economic activity in capitalist societies. The end of the
Bretton-Woods system did not only change the way exchange rate movements and
international capital flows are organized. A “regime change” occurred that led to a
dynamic adjustment of capitalism, in which finance becomes increasingly important
(financialization). Regrettably, there have been only few attempts to characterize
these two phases of economic history holistically.
The chapter first introduces the concept of “macro regimes” as a framework for
analyzing macroeconomic aspects during periods of large social transformations.
Building on approaches from political science and sociology, macro regimes are
defined as arrays of implicit or explicit principles, norms, rules and decision-
formation procedures that lead to a convergence of actor expectations. Both the
convergence of expectations (i.e. the emergence of regimes) and the divergence of
expectations (which usually marks the beginning of a regime change) are reflected
in specific characteristics of time series.
In the view of many observers from other social sciences, a characteristic feature
of the macro regime in the last four decades is the increasing role of finance in
society. This element of the current macro regime, often coined financialization, is
the focus of the chapter. Can the macro regime approach itself explain financializa-
tion? What does financial sociology contribute to its understanding? And how could
financialization happen on the watch of economic experts that now frequently reject
it?
Thereby, this volume ends with a reflection on the roles that economics in general
and macroeconomics in particular play in our society. This question has also been
characteristic for the symposium held in honor of Gerhard Illing and for Bob
Solow’s letter at the very end of this book. Solow asks: “Why is it so difficult?”
referring to the combination of expert technique with common sense in economics.
One explanation might be that economics is faced with a difficult double role. On
the one hand, it can be considered a science (the objective of which is to distinguish
true and false). On the other hand, it is a toolbox for policy. Put differently, it is
a language that is employed within the economy to organize discourse about the
economy. In this second role, it is highly political, applied, sometimes useful, and
sometimes counterproductive.
Gerhard Illing has taught many people how to walk on the fine line between
academic scrutiny and policy relevance that emerges from this double role.
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Frank Heinemann is professor of macroeconomics at the Berlin University of Technology.

His main research interests are monetary macroeconomics, financial crises, and experimental
economics.
Ulrich Klüh is professor of economics at Hochschule Darmstadt. His main research interests are
macroeconomic theory and policy, central banking, financial markets and institutions, and history
and theory of economic thought.
Sebastian Watzka is senior economist at the Macroeconomic Policy Institute (IMK) at the
Hans-Böckler-Foundation. Before joining the IMK he was assistant professor at the Seminar for
Macroeconomics of the University of Munich, LMU. His research interests are monetary policy
and financial markets, financial crises, inequality and unemployment.
Part I
Liquidity From a Macroeconomic
Perspective
Balancing Lender of Last Resort Assistance
with Avoidance of Moral Hazard
Charles Goodhart
Abstract Solvency is rarely clearly defined, since it depends on valuations relating

to future outcomes, which are themselves affected by policy decisions, including
Central Bank Lending of Last Resort (LOLR). Positive LOLR may cause losses and
moral hazard, whereas refusal could trigger a contagious panic. Measures to limit
moral hazard, and hence allow more systemic protection include: (i) treating the
first failure more strictly; (ii) involving other banks in any rescue; (iii) toughening
the incentive structure for bank borrowers.
1 Introduction
If an agent is certain to repay her debts, on time and meeting all the required terms
and covenants, she can always borrow at current riskless market interest rates. So a
liquidity problem1 almost always indicates deeper-lying solvency concerns.
The solvency concerns that lenders may have about borrowers may, or may not,
however, be well founded. I start in Sect. 2 by noting that the definition of solvency
is fuzzy. The future likelihood of a borrower defaulting is probabilistic, and so the
terms (the risk premia) and conditions on which a borrower can raise cash, her
access to liquidity, are stochastic and time varying, Sect. 3.
There is a common view that a Central Bank should restrict its activities
in support of financial market stability to lending into the general market via
open market activities, rather than lending to individual banks via Lender of Last
Resort (LOLR) measures. I explain why I disagree with that argument in Sect. 4.
Nevertheless the banks most in need of LOLR will generally be those that have been
least prudent. Even though the Central Bank will choose not to support the most
egregiously badly-behaved (and/or those whose failure is least likely to generate
1
That may be defined as an inability to access cash to meet due outflows, except perhaps at
enhanced premia that reveal existing solvency concerns to a wider public.
C. Goodhart ()
London School of Economics, Financial Markets Group, London, UK
© Springer International Publishing AG 2017 19

F. Heinemann et al. (eds.), Monetary Policy, Financial Crises,
and the Macroeconomy, DOI 10.1007/978-3-319-56261-2_2
20 C. Goodhart
secondary contagious-failures), the use of LOLR does entail a degree of insurance

(against failure) and hence generates moral hazard. I discuss in Sect. 5 various ways
of mitigating such moral hazard.
2 The Meaning of Solvency?
The use of language in macro-economics is slipshod2 ; (perhaps this helps to explain

our penchant for arid mathematical models). Solvency is just such a slippery term.
We think that we know what it means, i.e. that the value of assets is greater than
the valuation of the liabilities. But in practice we do not, because it all depends on
how the assets (and liabilities) are valued, and that depends on the viewpoint of the
valuer, and also on the (changing) conventions and practices of the accountant.
Consider, for example, the British mortgage bank (Northern Rock) in September
2007, at the time when it asked the Bank of England for liquidity assistance.
Looking backwards, to the prior bubble phase, it had very few non-performing
loans, and was undoubtedly solvent (historic cost accounting). Looking forwards,
to the likely future bust phase in housing, it was most probably insolvent (since it
had expanded aggressively), as turned out later to be the case.
Moreover, the assessment of the solvency of an institution, especially one seeking
LOLR assistance from a Central Bank (CB), is not independent of the CB’s own
actions and of the wider public’s (the market’s) interpretation of those same actions,
(as in the case of Northern Rock).3 The valuation of a going concern (where any
help has been covert) is much greater than that of a concern, which is either gone or
2
Examples are:
1. ‘Real’, as in real interest rates: Really means ‘adjusted for (expected) price changes’, but
whose expectations and what prices? Not much ‘real’ about it; at best ‘uncertainly measured
adjustment for future price changes’.
2. ‘Natural’, as in the natural rate of unemployment. Really means the level at which some
other variable, e.g. inflation, would remain stable. Often treated as being synonymous with
‘equilibrium’, but equilibrium carries a connotation that there are forces restoring such an
equilibrium, once disturbed. This latter remains contentious.
3
When LOLR assistance to a bank is revealed, the reaction can either be one of relief, i.e. the
Central Bank will now restore order, or of greater concern, i.e. I did not know things were so bad.
In the case of Northern Rock, Robert Peston of the BBC leaked that LOLR and had no incentive
to calm the public. Moreover, Northern Rock had many depositors who interacted electronically.
When a large number of these sought to withdraw simultaneously, the Northern Rock website
crashed. The depositors interpreted this as a refusal of Northern Rock to allow withdrawals, and
physically ran to do so from their nearest branch. Similarly when the authorities, e.g. the Treasury,
guarantees the withdrawal value of an asset, as in the Irish bank deposits or US Money Market
Mutual Funds, in 2008, this may calm the situation so that no further supporting action is needed.
But alternatively, if the potential financial losses are feared to be large and the solvency of the
guarantor is itself questionable, as it was in the Irish case, this can lead to both entities, guarantor
and guarantee, dragging each other down, in a ‘doom loop’.
Balancing Lender of Last Resort Assistance with Avoidance of Moral Hazard 21
needed patent public help to continue; hence there is a serious stigma effect of being
observed to need LOLR assistance from the Central Bank, with potentially severe
effect in delaying and distorting recovery processes.
Accountants have their own incentives. Although it is a crime to continue trading
when knowingly insolvent, I am unaware of any bank having closed its doors
because its accountant told them to do so. But, once a bank does close, most often
because its liquidity problems become insuperable, the incentive of an incoming
forensic accountant will be to exaggerate the potential scale of problems, thereby
fuelling potential panic and risk aversion, because such an accountant will not want
to have to claw back money from creditors on a future occasion, to meet further
losses, if, indeed, such future claw back can be done at all. Too often creditors are
originally told to expect large losses, whereas, after several years and a recovery
from the crisis, they get paid back practically in full, (e.g. as in Lehman Bros
London).
3 A Liquidity Problem Is a Solvency Problem
So (forward-looking) solvency problems exhibit themselves as liquidity problems.

Borrowers, including banks, would, as a generality, not have a problem in gaining
(funding) liquidity from markets if they were perceived as absolutely certain to pay
back in full as contracted. There are a very few technical exceptions, where timing,
terrorism, IT breakdowns, as with Bank of New York in the 1980s, or some other
exogenous event prevents access to markets; but the common, heuristic rule is that
a shortage of liquidity presages (market) concerns about solvency.
The CB then has to balance concerns both about potential loss from LOLR
lending and the implications of being seen to support risk-loving, even reckless,
management on the one hand (if it does support), against concerns about fuelling the
panic, amplifying downwards pressures on asset prices and contagion on the other,
(if it does not support). It is a difficult act of judgment, and there are no absolute
clear rules.
In particular, the ‘solvency’ of any potential borrower is not a deterministic,
exogenous, knowable datum, but depends on many time-varying future develop-
ments, not least how the CB itself responds to requests for LOLR assistance, and
whether (and how) that becomes known. There is a most unhelpful misinterpretation
of Bagehot (1873) that contends that he claimed that the Bank of England should
only lend to solvent institutions.
But the Bank of England had no supervisory powers then, or the right to
inspect other financial institution’s books. So how could the Bank of England know
who was solvent, and who not? Instead, what he meant, and said clearly, in his
second rule for LOLR is that the Bank of England should lend freely on all ‘good
22 C. Goodhart
securities’.4 The criterion for Bagehot was the quality of the collateral, which could
be assessed,5 rather than the solvency of the borrower, which could not be.
4 Lend to the Market, not to an Individual Borrower?
There is a common view, more prevalent in the USA than in Europe, that the
authorities, including the CB, should intervene as little as possible in markets, and/or
that markets are better informed (efficient market hypothesis) than any authority can
be, (despite CB’s role as supervisor). If so, so it is asserted, in a panic the CB should
provide liquidity to the market as a whole via open market operations, and leave the
distribution of such liquidity to the market, which will sort out those deserving of
support from those who should be let go, (better than CB).
This is, I believe, wrong, because it fails to grasp the dynamics of contagion. In
a panic, the weakest is forced to close. Its failure will worsen the crisis. The market
will then withdraw funds from the next weakest, further amplifying the downwards
spiral. To prevent total collapse at some point the authorities will have to step in to
support every institution which can meet certain criteria, as the G20 did in October
2008. Bagehot’s criterion was the availability of ‘good collateral’.
Such was the political revulsion from public sector support, ‘bail out’, of the
banking sector in the USA, that the conditions under which the Fed could provide
liquidity support to individual financial institutions were made somewhat more
4
‘The great majority, the majority to be protected, are the “sound” people, the people who have
good security to offer’, p. 198, (1999 version: John Wiley: NY. HG3000. L8283).
5
But if the collateral was good, why could not a bank raise money on the open market? There
are two answers to this, the first being more applicable to the nineteenth century, the second more
to subsequent centuries, twentieth and twenty-first. First, during panics financial markets tend to
become dysfunctional, with no one being prepared to part with cash at any reasonable price. In
such circumstances, the Central Bank is not only the Lender of Last Resort, but also the market
maker of last resort. In such a situation what interest rate should it set? As Bagehot states, a ‘high’
one, but obviously not a ‘penalty’ rate. Bagehot never uses the word ‘penalty’ in this context.
Second, such has become the stigma of being seen to borrow on LOLR terms from the Central
Bank that banks tend to use up all their good quality collateral to borrow from the market, before
turning, if all else fails, to the Central Bank for succour. With banks also of the view, prior to
2007–2009, that they could always borrow cash in wholesale markets (funding liquidity), they had
run down their holdings of high quality liquid assets to almost nothing at the start of the Great
Financial Crisis. So amongst the various unconventional monetary measures then taken were those
that swapped less liquid assets (held by banks) for more liquid assets, e.g. Treasury Bills. The Bank
of England’s Special Liquidity Scheme is a prime example. In the aftermath of the Great Financial
Crisis various requirements have been put in place, such as the Liquidity Coverage Ratio, to try to
ensure that banks will always have enough high quality liquid assets to enable banks to be rescued
from a panic, and associated liquidity troubles, without forcing the Central Bank to choose between
accepting poor collateral, i.e. taking a credit risk, and letting that bank fail.
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takes a full hour of travel before you can check in. I don't like to
walk."
"Right. I'll see what we can do."
"Good."
One-tenth of a light-second away, an aide entered Stellor Downing's
cabin. "Recognition, sir," he said. "Flight Commander Lane, from
Venus. I thought you'd like to know."
"What's his course?" clipped Downing.
"Mojave."
"Tell the tech to drop interferers. Tell navigator to correct course for
blitz-landing, and tell pilot to streak for landing Circle One. Also
broadcast crash-warning."
"Right. We're going in if we have to collide to do it, sir?"
"We'll have no collision. Lane wouldn't care to scrape any of his
nicely painted little toys."
"On the roger," said the aide, leaving immediately.
Two flights of ships changed course.
Down on Mojave, in the control and operations tower, signal officer

Clancey's face popped with beads of cold sweat. He sat down
heavily in a chair and:
"Tony! Get me the chief!"
"What's wrong, sir?" asked Tony.
"This desert ain't a big enough landing field to take on Lane and
Downing. Not all at once."
"Lane and Downing!" Tony streaked for the telephone. He called,
and handed the phone to Clancey, who plugged it into his
switchboard, putting it on his own headset so that he could hear both
the chief and the operations.
"Chief. Look, this is too hot to handle. Lane and Downing are both
heading for Mojave."
"I know."
"Do you?" asked Clancey sarcastically. "They're heading for Mojave.
They're racing for Number One. And they're due to arrive within
three or four milliseconds of one another!"
"Hell's Rockets!" exploded the chief. "Get 'em on the air and tell 'em
they're under orders."
"There isn't any air. One of 'em dropped interferers."
"Official?"
"Unofficial."
"O.K. Record the fact and then go out and watch. It's out of your
hands if they can't hear you. As long as you have a record of
interference it's not your cookie. It belongs to them."
"Mind if I head for a bomb-shelter?" grinned Clancey.
"Oh, they're both smart. That's one fight that never hit an innocent
bystander."
"—yet," added Clancey.
"Well—?"
"It might be the first time I died, too," objected Clancey.
"You don't want to live forever, do you?"
"Wouldn't mind."
"Nuts. There must be something good about dying. Everybody does
it."
"But only one; never again."
"Well, play it your way. I sort of wish I could be there to watch, too."
"Just tell mother I died game. So long, chief. I hear music in the air
right now, and hell will pop directly."
Like twin, high-velocity jets of water, the two space flights came
together, rebounded off of their individual barrier-layers and mingled
in a jarring maze of whirling ships. In a shapeless pattern they
whirled, and they might have whirled shapelessly all the way to
Mojave, except for one item.
From Downing's lead ship there stabbed one of the heavy dymodine
beams, its danger area marked with the characteristic heterodyne of
light. It thrust a pale green finger into the sky before it, and as it
came around, the other ships moved aside. That was the breaker.
The flights reformed into twin interlocked spirals that thrust against
one another with pressors and tore at one another with tractors in an
effort to break up the other's flight.
Lane snapped: "That's a stinking trick."
"He's warning—"
"Oh, nice of him to heterodyne it. I wish I had a roboship. I'd drive it
into his beam and tell him that he clipped my men—"
Stellor Downing grinned at his unit commander. "I told you he'd
duck," he said loftily.
"Wouldn't you?"
"Nope. I'd drive into it and see if he'd shut it off before I hit it."
"Supposing he didn't shut it off?"
"Don't ask me," said Downing. "If he did, it would be to spare the
men with me. If I ducked at the last minute, it would be for the same
reason. If we were alone, I wouldn't dive into a beam—but we might
try a bit of rivet-cutting."
The unit commander's face whitened a bit. That was an idea he
disliked. And yet some day he knew they'd get to it. Just as
practically everybody knew it.
The hard ground of Mojave whirled up at them, and the twin spirals
flattened out. Like a whirling nebula, they spun, slowing as they
dropped.
Clancey groaned from the top of the tower: "There ain't room for fifty
ships in Circle One. There ain't room for six ships fighting one
another. Holy—"
The spattering of force-beams, tractor and pressor, died as the last
hundred feet of altitude closed in. The ships, still wabbling slightly,
slowed their spinning around and curved to drop vertically for fifty
feet.
The ground shook—
And there was left but one dustless landing circle at Mojave—the
other one.
Windows in the control tower cracked, a fuse alarm rang furiously,
and somewhere a taut cable snapped, shutting off the fuse alarm for
lack of juice. The lights went out all over the Administration Building,
and every ceiling dropped a fine shower of plaster freckles.
They landed on empty desks and open chairs.
Seven thousand employees of Mojave were crammed out on the
view-area, wiping the dust from their eyes and shaking their heads.
And through the dust, weaving their way between the ships of either
command. Cliff Lane and Stellor Downing advanced upon one
another.
Out of a cloud of dust came Lane. Downing emerged from the other
side and faced the Venusite.
"You fouled me," snarled Downing.
"Who, me?" asked Lane saucily.
"I broadcast a crash-warning."
"You should have done it before you dropped interferers. All I know
is that you disputed my course."
"So I did. So what?"
Lane reached for a cigarette. He did it with his left hand, though he
knew that Downing wouldn't draw his modines while either hand was
occupied. Downing was fair, anyway. "So you didn't get what you
wanted—again."
"Neither did you."
"All right. Are you happy? Got to have the best, don't you?" growled
Lane. "Can't stand to see anybody take even a toothpick that you
can't have two of."
"If you were more than a drug-store cowboy ... brother, what a get-
up."
Lane flushed. "My clothing is my own business."
"It's very fetching. Chic, even."
"Shut up, dough-head. I'm not forced to wear an iceman's uniform so
people won't think—"
"What's the matter with me?" gritted Downing.
"You might at least put on a clean shirt," drawled Lane, tossing his
cigarette at Downing.
"Oh, swish—"
That did it. Lane's right hand streaked for his hip after a warning
gesture. Downing's two hands dropped and came up with the twin
modines.
Only a microtime film record would ever tell the quicker man. Their
weapons came up and forward and the dust of landing Circle One
was shocked with a sharp electrical splat.
III.
"And that's your job, Thompson," said Kennebec.
"And that's enough," responded Thompson. He wiped his face.
"Oh, I'll issue the proper orders. They'll receive them—and any trace
of insubordination on the part of either of them will be cause for
reprimand. Public reprimand."
"But the reason behind all this? I don't understand."
"Nor does anyone else. Look Thompson, the Little Man has a super
ship out there on Mojave. It is a real bear-cat. Packed into space
smaller than this office is enough stuff to hold off the Guard for a
week. That's premise number one.
"Number two. They have some sort of telepathic means of
communications.
"Number three. They came here for help. Why, I may never tell you
until it's analyzed by the experts. But they came here for help. A
machine, bomb, some means of hell and destruction or other must
be destroyed. It must be located, too. Using some means of analysis
on our card files, voice records, identification quizzes, and so forth,
they decided upon Lane and Downing as the mainsprings. They'll
have none other. Now why or wherefore isn't for me to decide. If they
want Lane and Downing, they'll get Lane and Downing and none
others. At the very least, we've got to play their game as long and as
well as we can play it. I want to have the Solar Guard equipped as
well as that ship is, and this is the way to do it."
"Why don't they go out and destroy this thing themselves?" asked
Thompson.
"I wouldn't know. You know as much as I do."
"They may fear the cat race."
"If I had their stuff, I'd fear nothing."
The telephone rang and Kennebec lifted it. He listened and then
hung up slowly.
"Your job—" he said. "Lane and Downing are making a running fist
fight to see who lands on Circle One. If you go a-screeching fast, you
might be able to make it by the time they hit."
"Right—" and Thompson left unceremoniously.
He hit the street, landed in his car, and was a half block away, siren
screaming, before he realized that he had a passenger. It was
Patricia.
"Huh?" he asked foolishly.
"Well, the engine was running, wasn't it?"
"I didn't notice."
"Fine thing."
"You must have heard."
"Who hasn't. Come on, Billy. A little more soup. I know that pair and
they won't waste time."
Thompson poured more power into the car and it increased in
speed. The way was cleared for him, though it took some expert
driving to cut around and through the traffic, stopped by the
demanding throat of the official siren.
Thompson roared up the main road to Mojave, sent the guard-rail
gates flying dangerously over the heads of onlookers, and sped out
onto the tarmacadam. The dust of the rough landing was just starting
to rise as Thompson slid into the outskirts of the circle of ships. His
car skidded dangerously on locked wheels, and he used the
deceleration of the vehicle to catapult himself forward. He landed
running and disappeared into the circling dust.
He could be certain that Lane and Downing would be at the center of
this whirling mass.
Lane blinked. Downing shook his head in disbelief. Both recharged

their modines and—
"That's about enough!" snapped Thompson, coming through the
dust. "You pair of idiots."
They whirled.
"No, you didn't miss, either of you." He waved his own modine. The
aperture was wide open. "But I've got a job to do and you aren't
going to spoil it on the first try. I'd hate to report to Co-ordinator
Kennebec that I'd failed—doubly. And that all there were to his plans
were two hardly scarred corpses."
He tossed his weapon on the ground and nursed his hand.
"You're the fool," said Downing. "Don't you know you can't absorb
the output of three on one of 'em?"
"I did," snapped Thompson. "Though I'd rather use a baseball bat on
both of you."
"We didn't intend to hurt anybody," explained Lane.
"Good. Now that that's over, you might play sweet for a while, doing
penance for burning my hand."
"You mean we're going to work together?" asked Lane in disbelief.
"And you're going to act as though you liked it."
"I won't like it," scowled Downing.
"Just make it look good. You've got a job to do, and once it is done
you can go rivet-cutting for all I care."
"It's an idea."
"All right. But listen, you pair of fools, Patricia is coming through this
haze you kicked up. Take it easy."
"Pat!" it was a duet.
"Yeah, though you should both call her Miss Kennebec after this
performance."
"You leave her out of this," snapped Lane.
"After one more statement. You fellows can fight all you want to, but
remember, if you're fighting for Pat, just consider how she'd feel to A,
if as and when A chilled B to get rid of B's competition. Now let's
behave ourselves—and if you're asked, this was a fine shindy; a real
interesting whingding."
Clancey saw the four of them emerge from the aura of dust and he
held his head. "Look at 'em, chief. It ain't goin' to last. I know it ain't.
Mis's Kennebec holding an arm of each of them and Mr. Thompson
chatting to all three from behind."
"Clancey, this may be the calm before the storm. But from what I
hear, both of them will be a long way from Sol when the tornado
winds up. They're heading for the Big Man's office right now. He'll tell
'em."
"I think I get it," said Lane. "He wants us to analyze it. That's why this
motion of our heads to the thing."
"You may be right."
"This is a long way from here, though. I don't quite get it."
Kennebec explained his reasons for playing the Little Man's game.
"O.K., chief. I've heard of this cat race," said Downing.
"You have?"
"Only malcontent rumors. Tramps, adventurers, and the like are
inclined to take runs like that for the sheer loneliness of it—and the
desire to set foot where no man ever stood before. It's about the limit
of run with even a Guard ship. I suppose any rumors can be
discounted, but I've been given to understand that they are a rather
nasty kind of personality."
"Being cats they would be," added Lane.
"Not necessarily," objected Thompson. "We are basic primate-
culture, but we don't behave like apes."
"No?" asked Kennebec with a sly smile.
"O.K."
"Now," said Kennebec. "They've chosen you two for the job in spite
of our explanations that you are slightly inclined toward dangerous
rivalry. Why they insist I do not know. Be that as it may, gentlemen,
you have this project. You have twenty-five ships each, all armed to
the best of Solar technique. You'll have to play it close to your vest, I
gather, since this machine or bomb is at present running through
their system. Therefore I order you, officially, to refrain from any
competitive action until this project is completed. The Little Man has
detectors to locate the thing, you'll each get one of them. Track it
down and analyze it. Destroy it after you could reproduce it.
Thompson, your only job is to remind this pair of worthies that their
prime job is to finish this project."
"It may be not too hard," smiled Thompson. "I won't have any
trouble."
"Look, Downing, if this thing is as important as they claim, we're fools
not to work together. Right?"
"As corny as it sounds—the fate of races depends—I believe the
Little Man. Until this fool project is over, no fight."
"Shake."
Downing made a "wait" gesture. He picked up an ornate dinner
candle from the mantelpiece and lit it. He took cigarettes, offered one
to Lane, and they shook hands. And they lit their cigarettes in the
same candle flame.
And Thompson said to Kennebec: "A pair of showmen."
"And the best flight commanders in the Guard, confound it!"
Stellor Downing, out of his Martian uniform and wearing the dress
uniform of Terra, piloted Patricia Kennebec through the tables to a
seat. "Stop worrying," he laughed.
"I suppose I should," she admitted.
"Then please do."
"I will. It isn't complimentary to you, is it?"
"I wouldn't worry about that."
"All right. But I still think I'm fostering trouble for both of you."
"By coming out with me tonight? Lane asked—but he was late. He
can't object to my making plans first, can he?"
"He admitted that he had only himself to blame."
"Then?"
"But I can't help thinking that I'm the cause—"
"Look, Pat. Analyze us. Cliff is Venusite. His family went to Venus
about six hundred years ago—probably on the same ship that mine
left for Mars on at about the same time. Lane's impetuous and
slightly wildman. I'm more inclined to calculate. Dance?"
"Yes—that was a quick change of subject, Stell. How do you do it?"
"The music just started—and my basic idea in coming here was to
dance with you."
"How about ordering? They'll get the stuff while we're dancing."
"Everything's ordered," he smiled. He drew back her chair, offered
her an arm, and led her to the dance floor.
Downing's dancing was excellent. He was precise, deft, and graceful
despite his size. The orchestra finished the piece, and then with a
drum-roll introduction led into the classic "Mars Waltz."
The step was long and slow and though some of the other couples
drifted off the floor to await something more springy, they finished the
long number with a slight flourish.
Another drum-roll, and: "Ladies and Gentlemen," said the
announcer, "that number was in honor of Stellor Downing, number
one Flight Commander of the Martian sector of the Solar Guard!"
There was a craning of necks to see the Martian, and Downing
politely saluted before he retreated to his table.
"And in this corner ... pardon me, I mean over here, ladies and
gentlemen, we have Clifford Lane, the top Flight Commander of the
Venus sector!"
The necks swiveled like the spectators at a tennis match and the
spotlight caught Cliff, standing at the door with a woman on each
arm.
At a word from the manager, four large, square-shouldered men in
tuxedos accepted two tables. Base lines for defense—
But Lane merely nodded affably in the bright spotlight. "Thanks, and
now, professor, that light is bright. Play, George. The Caramanne if
you please."
"But I can't dance the Caramanne," objected the girl on his right.
"And I wouldn't dance it in public," said the girl on his left.
"Well, we all know someone who can and will," laughed Cliff. He led
them to Downing's table, shook hands with Stellor and underwent a
ten-second grip-trying match. He introduced them all around and
then asked: "Downing, may I steal her for a moment? I think she's
the only one present that can hang on while I take care of the
Caramanne."
"For a moment," said Downing.
The four men in tuxedos blinked and shook their heads. The
manager took a quick, very short drink. It was a draft of sheer relief.
The pulse-beating rhythm of the native dance of Venus started with
rapid tomtom, and then carried up into the other instruments. With
the floor to themselves, Cliff and Patricia covered most of it in the
whirling, quick-step.
"A fine specimen of fidelity you'd make," she laughed.
"Well, you were busy. I had to do something."
"You seem to do all right. They're both rather special."
"Know them?"
"Only by nodding acquaintance."
"Well, any time you have time to spare for Cliff Lane, just let me
know and I'll toss 'em overboard and come running."
"And in the meantime?"
"And in the meantime, I'm not going to rot."
The dance swung into the finish, which left them both breathing hard.
Lane escorted Patricia back to the table, where Downing sat silent.
As they came up, a third man approached. Lane seated Patricia and
then greeted the new-comer.
"Hi, Billy. Lucky, we've got a girl for you, too."
Thompson breathed out. "Oh," he said surveying the situation. Both
situations looked him over and smiled. "Lenore, and Karen, this is
Billy Thompson. He's in division."
"Which division?" asked Lenore.
"Subdivision," grinned Thompson. "I'm the guy they got to comb
these guys out of each other's hair."
"Poor man," sympathized Karen.
"You gals match for him," laughed Cliff. He tossed a coin.
"Heads!" called Lenore.
"You lose—take him," chuckled Lane.
Lenore put her arm through Thompson's. "Nope," she said brightly, "I
win."
The spotlight hit the table. "We might as well finish this," laughed the
announcer. "I present the referee ... pardon me, folks, I mean the top
man of the Terran sector; Flight Commander Billy Thompson!"
The music started, and all three couples went to dance to a medley
of Strauss' waltzes.
IV.
"It was all sort of whirligig, like," explained Patricia. "We didn't get
home until along toward the not-so-wee large hours of the morning."
"I know," responded her father dryly. "The whole gang of you were
raiding the icebox at five."
"The rest of them left shortly afterward."
"All of them?"
"No, Stellor outsat them and lingered to say goodnight."
"What do you think of Stellor?"
"I've always thought highly of Stellor. He's got everything. He knows
what he wants and he knows how to get it."
"And Cliff Lane?"
"Cliff is strictly on the impulse."
"I wouldn't say that," objected her father. "After all, both of them got
where they are because of their ability."
"Well, Cliff gives the impression that he just thought of it."
"Of what?"
"Of whatever he was going to do next."
"A good thing nobody ever asked you to decide between them."
"It would be difficult."
"Well, it won't be necessary. They're leaving after the next change of
watch."
"So soon?"
"The Little Man gave the impression that all of us were fighting for
time."
"I see. You do believe that this is important?"
"I can see no other reason for it."
"Um-m-m. Well, I'll be down to see them off."
"All of us will."
"I was worried, last night. I could see a beautiful shindy in the offing."
"And it didn't get bad at all?"
"No," answered Patricia in surprise. "I think Cliff saved the day by
showing up with a couple of women. I wouldn't have wanted to sit
between the two of them all by myself. That would have been strictly
murder. And I wouldn't have wanted to see Stellor off without saying
farewell to Cliff. Stellor got here first with the plans—I was strictly a
fence. I didn't know what to do. So I did it. And everything turned out
fine."
"You can hope that it will always turn out fine. What'll you do if one of
them turns to some other woman?"
Patricia laughed wryly. "I'd lose both of them, Dad. Believe me, I
would. The other would barge in and set sail for the woman just as
sure as I'm a foot high."
"But ... but ... but—"
"I don't really know—nor do I care too much."
"Anticipating me? You mean you don't know which one really wants
you and which other is just here for sheer rivalry?"
Patricia nodded. "They don't, either," she said sagely. "It is a good
thing that we have time. Time will out, as you've always said. Time
will get us the answer. Right now I'm neither worried about time, or
even not having my mind made up on a future. I've got a number of
years of fun ahead before then."
"Bright girl," laughed Kennebec. "Now let's get going. We want to
see them off, don't we?"
Two hours later, seventy-five of the Solar Guard's finest ships

arrowed into the sky above Mojave. In the lead, determined by a toss
of the coin, was Stellor Downing's command. Thompson's outfit,
running to his own taste, encircled the Downing cone at the base in a
short cylinder, while bringing up the rear was Cliff Lane's long spiral.
An hour out of Mojave, the flight went into superdrive and left the
Solar Combine far behind in a matter of minutes.
By the clock, it was weeks later that the Solar Guard's flight dropped
down out of superdrive and took a look around. The Little Man, in
Thompson's ship, used his own instruments and indicated that the
yellow star—it was more than a star at their distance—dead ahead
was the one they sought.
"Downing," called Lane. "How's your power reserve?"
"Like yours, probably."
"We'd better find a close-in, hotter-than-the-hinges planet where they
won't be populating and charge up, what say?"
"Good idea. Better than the original plan of charging in flight. If it's
close in, it'll have ceased revolution, probably. We can hit the twilight
zone and rest our feet a bit."
"O.K. I'll put the searchers on it."
"We'd better take it by relays, though. A fleet that's planeted for
charging isn't in the most admirable position for attack."
"Reasonable. You charge, Thompson'll guard, and I'll scout around."
"You'll do nothing of the sort," growled Downing. "You and Thompson
will both guard."
"Afraid?"
"No, you idiot. I'm jealous as hell. I don't want you to take all the
glory."
"And that's probably the truth," laughed Lane.
"Take it or leave it."
Thompson interrupted. "This sounds like the leading edge of a fight.
Stop it. We'll play it safe—Downing's way."
"O.K.," assented Lane cheerfully enough.
"Thing that bothers me," muttered Downing, "is the fact that if this
bunch have any stuff, we're being recorded on the tapes right now."
"So?"
"And if they're as nasty as the Little Man claims, they'll be here with
all of their nastiness."
"All right," snapped Lane. "We've got detectors and analyzers,
haven't we?"
"Uh-huh. But we're a long way from home base. What we've got
we've got to keep—and use. They can toss the book at us and go
home for another library. Follow?"
"Yup. Located a planet yet?"
"Haven't you been paying attention?"
"No. You're in the lead. I'm merely following as best I can."
"Then sharp up. We're heading for the innermost planet now."
"Go ahead—we'll go in to see. Then Lane and I will scout the sky
above to keep off the incoming bunch, if any," said Thompson.
It was an armed watch. Downing's flight landed and set up the solar
collectors. From the ships there came a group of planet-mounted
modines which had little to offer over the turrets in the ships save
adding to their numbers.
The other two flights dropped off their planet-mounts, too, since they
were of no use a-flight and might even become a detriment if trouble
demanded swift maneuver.
Then a regular patrol schedule was set up and alternately Lane and
Thompson took to the sky to cover the area. The detectors were
overhauled and stepped up to the theoretical limit of their efficiency,
and couplers and fire-control systems were hooked in and calibrated.
It took nine days by the clock to get the camp set up, and Downing's
flight was almost recharged by the end of that time.
As Thompson's flight went in for re-charge, Downing and Lane
discussed the camp.
"I say leave it here," said Lane. "Might be handy."
"When?"
"I don't have any real idea. But we've got one hundred and fifty extra
dymodines planet-mounted down there. I say leave it there until we
get this problem off our chest."
"Expect trouble?" scoffed Downing.
Lane nodded. "I expect this to end in a running fight with one of the
two of us making a blind but accurate stab in the dark and getting
that machine the Little Man talks about. If the going gets tough, we
can hole out here for some time with the solar collectors running the
planet mounts."
"Wonder why the cat race hasn't come up," mused Downing. "It isn't
sensible to permit any alien to establish a planethead in your
system."
"They might not even know."
"Unlikely."
"Look, though," offered Lane, "we came in sunward, almost
scorching our tails. The solar centroid of interference might make
any flight detection undistinguishable from background noise."
"Yeah? Remember that we came in over the edge of the sun from
somewhere. We were out in space mostly."
"Then you answer it—you asked it!"
The catmen came as Thompson's flight left the camp and Lane's
ships dropped into the charging positions. They came in a horde,
they came and they swarmed over the two flights that were
patrolling.
In a wide circle, the Solarians raced just outside of the camp. The
planet mounts covered the sky above, and a veritable arched roof of
death-dealing energy covered the twenty-five ships of Lane's flight.
The space between the Solar circle and the catman circle was
ablaze with energy, and the ether was filled with interference. Even
the subether carried its share of crackle, and the orders went on the
tone-modulated code instead of voice.
Solid ordnance dropped, and exploded through the crisscrossing of
the planet mounts, and the planeted ships ran their charges down
instead of up by adding to the fury over their heads. They were
sitting ducks and they knew it.
But unlike the sitting duck, these could shoot back. And they took
their toll.
Then without apparent reason, the flight of catmen left their whirling
circle on a tangent and streaked for space.
Behind them lay nine smoking ships—prey to the Solar Guard.
But they had not gone in vain. There were seven of the Solar Guard
that would fly no more—seven ships and a total of one hundred and
seventy-five men.
"Whew. They haven't any sense at all," snarled Downing.
"Either that or they value their lives rather poorly."
"Must be. I wouldn't know. But usually a vicious mind doesn't value
life too highly."
"I wouldn't be too certain of that."
"All right. I won't belabor the point. I don't know. It just seems—"
The next ten days was under rigid rule. Lane's ships charged, and
the last day was spent in replenishing the charges lost in the short
but torrid fight.
"Now," said Lane, "what's with this hell-machine that the Little Man
mentions?"
"The detectors do not detect," objected Downing.

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MONETARY POLICY FINANCIAL CRISES

CLICK LINK TO DOWLOAD

Emerging Research on Monetary Policy, Banking, and

Currency Internationalization and Macro Financial Risk

Monetary policy within the IS LM framework First

Macroeconomic Policy after the Crash : Issues in

Bank Liquidity Creation and Financial Crises. New

Drought and Water Crises: Integrating Science,

Foucault and Post-Financial Crises: Governmentality,

Crashed How a Decade of Financial Crises Changed the

ISBN 978-3-319-56260-5 ISBN 978-3-319-56261-2 (eBook)

Library of Congress Control Number: 2017951194

© Springer International Publishing AG 2017

Printed on acid-free paper

This Springer imprint is published by Springer Nature

This volume contains invited contributions by (former) students, colleagues, and

to macro problems. This is reflected in an insurance-based approach to evaluate

Berlin, Germany Frank Heinemann

Monetary Policy, Financial Crises, and the Macroeconomy:

Part I Liquidity From a Macroeconomic Perspective

Part II Putting Theory to Work: Macro-Financial Economics

Macroprudential Analysis and Policy: Interactions

Part III Re-Conceptualizing Macroeconomics:

Greetings from Bob Solow . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 351

Frank Heinemann, Ulrich Klüh, and Sebastian Watzka

© Springer International Publishing AG 2017 1

Gerhard’s approach to macroeconomic analysis is unique in the way it balances

1 Liquidity and Contagion of Financial Crises

It is difficult to overestimate the role of liquidity as a key or possibly even

value to outside investors is higher in market-based systems, where information is

inter-temporal decisions, because interest-rate policies prevent the free adjustment

2 Putting Theory to Work

Macroeconomics is a policy-orientated science. A main challenge is to take theory

macroprudential regulation, because credit risk estimates do not improve (dete-

volume looks at five elements of this trend:

Frank Heinemann is professor of macroeconomics at the Berlin University of Technology.

Abstract Solvency is rarely clearly defined, since it depends on valuations relating

© Springer International Publishing AG 2017 19

secondary contagious-failures), the use of LOLR does entail a degree of insurance

2 The Meaning of Solvency?

The use of language in macro-economics is slipshod2 ; (perhaps this helps to explain

3 A Liquidity Problem Is a Solvency Problem

So (forward-looking) solvency problems exhibit themselves as liquidity problems.

4 Lend to the Market, not to an Individual Borrower?

Down on Mojave, in the control and operations tower, signal officer

Lane blinked. Downing shook his head in disbelief. Both recharged

Two hours later, seventy-five of the Solar Guard's finest ships

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